Q2 DeFi Report

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Looking beyond the headlines and TVL real activity levels may be a lot lower than currently being hyped.

2020 has been the year of DeFi. With the emergence of liquidity mining, the sector has seen a flood of investor and user capital as well as developer interest. The new incentive models have captivated market participants with triple-digit gains, while a host of successful IDOs may have started the next fundraising trend.

The Ethereum ecosystem has been the main beneficiary of the DeFi wave, but key competitors are now looking to replicate its success on their own network. A token economy depends on the users’ ability to seamlessly exchange assets, making DeFi a foundational component for other sectors.

However, it is important to look beyond top-level numbers. With the hype surrounding the sector growing, dollar valuations have ballooned. This in turn may be distorting the view of how much activity there is on the networks, fueling a new bubble.

Ethereum DeFi leads the pack

The number two blockchain has re-established itself as the number one dapp platform in the industry. Despite concerns surrounding scalability and skyrocketing transaction costs, Ethereum has been at the center of user and developer activity in DeFi.


The number of daily active wallets has been steadily increasing since 2019. However, Ethereum has seen a major jump over the summer months. No surprise this coincided with the governance token boom, with COMP making the most noise initially.


Compound, daily active addresses numbers have retreated to their pre liquidity mining state. This may in part be due to other more attractive options being available, optimization and management, and optimization projects eating up the volume.

Tron has been quickest to try to follow in Ethereum’s footsteps, launching JUST (its version of MakerDAO) as well as announcing JUSTswap (its Uniswap alternative). This has given Tron a sizable boost in terms of active user wallets, but since Tron’s DeFi presence was negligible prior to this summer, it is still far from being an alternative to Ethereum.


EOS also hosts a number of DeFi applications, but it is hardly a player in the sector for now. The past few months also saw a number of key developments among layer one protocols, most important of these being the launch of Shelley by Cardano. With Ethereum 2.0 still being worked on, Cardano offers a viable PoS alternative for DeFi projects.

It is important to remember that wallets are not users, as one user can have many wallets. As such AUW statistics on their own can provide a distorted view of the ecosystem. Transaction volume data can help fill in some of the gaps.

Despite the fact Ethereum transactions became expensive, the network saw a steady increase in volume. Tron and EOS on the other hand saw much smaller activity with EOS developing a negative trend.


The emergence of liquidity mining and governance tokens

Two key trends fueled the DeFi boom. One has been liquidity mining. Projects such as Compound, Synthetix, Ren, Balancer, Uniswap, and Curve set up (often interconnected) reward systems for users to engage with the dapps’ liquidity pools.

The other trend has been to seek greater decentralization. Projects have started to move towards a DAO model, often issuing governance tokens that give users the right to propose and vote on initiatives that govern the project.

In the case of Compound, the two trends came together as COMP is being distributed to those borrowing and lending on the dapp.

While there is a fair amount of debate regarding the value of the tokens and what they represent there is no denying they have generated a lot of excitement. Existing projects have started thinking about moving to a DAO model and launching a token, while new projects are incorporating it from inception.

TVL and the power of the dollar

DeFi needs capital. The more capital is in the system the more liquidity there is, the easier it is to maintain a seamless flow of assets and sustain incentive models. So TVL has become a key metric for the industry. The problem is, it is not suited to be a master metric.

Over the past few months, the industry has been excited about the growing TVL values associating them with increased engagement and protocol valuation. At first glance, the accumulation of capital has been impressive, with MakerDAO even crossing the $1B mark.

However further, inspection reveals a different story. Most often the TVL numbers are quoted in dollars and are not adjusted for inflation. So it may look like there is an inflow of capital, while in reality, the change is due to the increase in prices.

This can be clearly seen in projects that have a dominant (majority of the collateral pool) collateral assets, such as MakerDAO (ETH) and Synthetix (SNX).

While the media is quick to quote the impressive dollar value of TVL, the inflation-adjusted picture looks a lot tamer.

Furthermore, TVL ignores user activity. The crypto industry is known to be impacted by whale activity. As such, more capital cannot be assumed to equate to more users. Moreover, the use of bots in liquidity mining (or yield farming) has pointed to a high degree of centralization in protocols, even as many try to decentralize.

Abstracting the complications

As the DeFi sector grows, it begins to offer more and more options to participants. However, for many retail users, the UX and the underlying math may be too complicated. Even checking interest rates across or pool liquidity across different dapps requires significant effort.

As such, we are seeing a number of services take the spotlight that aims to simplify the user experience. Projects like InstaDapp simplify asset management and even the process of yield farming, while something like yearn.finance tries to help users allocate capital more efficiently.

While projects like Balancer and Set Protocol help users create their own financial assets, something like Furucombo enables the mixing and matching of various DeFi instruments.

The development process appears to be rapid and innovative, however, it also creates an illusion of ease and safety. As new DeFi products abstract the complexities of the underlying protocols, retail users will find it harder to understand the risks they are taking on.

DeFi Risks are mounting

The DeFi ecosystem is growing and becoming more interconnected. This is highly encouraging, but it also carries risks. This year there were a number of high profile attacks and system issues that have affected the various dapps.

More and more we are starting to see “algorithmic” attacks, in which the actor is not exploiting a code flaw, but rather a design issue. The system behaves as intended, but the attacker exploits an edge case.

Since the dapps have become so interconnected, now there is a higher chance of a domino effect. The ecosystem is still developing and it is unreasonable to expect that flaws will not continue to be exploited by attackers.

Moreover, with the fat protocol thesis being questioned, DeFi may be growing too fast for the underlying security layer.

On the bright side, the sector and individual dapp communities have shown tremendous resilience. Whether it be dealing with the near-collapse of MakerDAO in March or yield farming getting too risky in Compound in July, communities have been able to implement necessary changes and take a step forward.

A look to the future

Q4 is set up to be filled with excitement. As the Ethereum ecosystem waits for Ethereum 2.0 other networks will be playing catch up. The increased interest from investors and the emergence of IDO as a viable option for raising capital means we are likely to see a lot of new projects coming into the sector.

However, it is important to keep in mind that the sector is still young and it is important to look beyond the headline numbers. Real activity levels may be a lot lower than currently being hyped. As such it is important to remain patient as the sector continues to mature.

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NB: The information provided here is for reference and informational purposes only. This is not investment advice and should not be treated as such.

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